Muni bond funds providing shelter from global market mayhem

Declining number of bonds drives total returns higher

Feb 4, 2016 @ 2:44 pm

By Jeff Benjamin

While the global financial markets have seemingly settled in for a fresh bout of volatility, municipal bond funds have remained relatively non-correlated to the turbulence infecting virtually every other investment category.

Inside the overall muni bond fund category, none of the 16 muni bond fund sub-categories, whether single-state or national, has a negative performance number for any period from one month to five years, annualized.

None of the eight other broad Morningstar categories is anywhere close to such a claim.

“It's basically been a perfect storm, in a positive way, for munis,” said Glenn Williams, president and chief executive of A.H. Williams & Co.

Even though the broad muni-bond fund categories aren't the best performers, they are the most consistently positive.

Since the start of the year, the muni national intermediate category is up 1.23%, muni national long term is up 1.17%, and muni national short term is up 55 basis points.

Over the trailing 12 months, through Wednesday, national intermediate is up 2.32%, national long term is up 2.61%, and national short term is up 60 basis points.

By way of comparison, taxable long-term government bond funds are up 5.04% since the start of the year, but the category is down 1.45% over the past 12 months.

Long-term corporate bond funds are up 1.98% this year, but the category is down 4.65% over the past 12 months.

The S&P 500 Index is down 6.28% from the start of the year, and down 4.68% over the past 12 months.


Market watchers and financial advisers like Mr. Williams cite multiple factors for the way muni bond funds have remained non-correlated from much of the market mayhem, but nobody is making any promises about future performance.

“At the macro level, interest rates have been low and going lower over the past six weeks, which means bond prices are going up,” said Ronald Bernardi, a muni bond portfolio manager at Bernardi Securities.

“As the equity markets have sold off rather substantially, the dynamic of higher bond prices and lower yields has exacerbated because people overreact by selling declining assets and move into those that are climbing,” he added.

Muni bond strength, Mr. Bernardi explained, is being fueled by a weaker stock market, a tight supply of muni bond issuance, a stable interest-rate environment, low inflation, and what appears to be status quo from the Federal Reserve.

Mark Paris, head of municipal portfolio management and trading at Invesco, adds to that list the geographical cover that muni bonds are currently providing by being generally protected from global markets and falling oil prices.

“This isn't just about their tax-exempt status, muni bonds are exemplifying good correlation to the tribulations of equities and the corporate bond markets,” he said. “Part of that low correlation is because muni bonds are, for the most part, not associated with the problems of lower oil prices.”

With the exception of Texas, Alaska and some of the less-populated states involved in the fracking industry, the majority of U.S. state budgets are not feeling the direct pain of cheap oil, Mr. Paris said.

“With low returns in equities, munis look like a good place to be right now, because we don't have the oil market exposure,” he said. “In muni bonds, you're sort of buying essential services like infrastructure bonds supporting toll roads and hospitals, because outside of taxes on gasoline, most states don't have a lot of income coming from oil.”


Supply and demand is also a factor, Mr. Paris added, citing five-consecutive years of what the market calls negative issuance, meaning more bonds were taken out of the market through calls and redemptions than were added through the sale of new bonds.

The last time the muni bond market saw positive issuance was 2010 when the federal government allowed for the one-time issuance of $182 billion worth of Build America Bonds, which are taxed like ordinary bonds and heavily subsidized by taxpayers.

In 2010, total muni bond issuance, including the Build America Bonds, was $440 billion, which compares to $330 billion last year.

“Over the past few years, states have done a good job of tightening their belts,” said Mr. Paris. “There has not been a lot of issuance, but there has been strong demand from investors, which pushes yields down, and that's good for total return.”

Meanwhile, Mr. Williams is watching the same supply and demand fundamentals unfold and he is feeling a bit more cautious.

“We see the negative supply and we realize that its cyclical, which means it works until it doesn't work,” he said. “On an absolute basis, the yields we're seeing now are near all-time lows, and I see a slowing in retail demand.”

Mr. Paris, however, is more optimistically focused on the relative strength of the category.

“Muni bonds are hanging in there well when people are taking it on the chin in equities and the corporate bond world,” he said. “Muni bond funds are products that don't have Chinese exposure, oil exposure, or European exposure. It's a pure play on the U.S.”


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